Prudential Regulation Authority Rulebook

6.1

Some transactions transfer little or no economic risk from the protection buyer to the protection seller, but may nevertheless result in a reduction in regulatory capital requirements. An example of such a transaction-type is one in which protection is purchased on a junior tranche and a high premium is paid for that protection.

6.2

Generally, the amount of premium paid will not materially affect the assessment of whether SRT is achieved. This is because either:

• the protection payment payable upon default from protection seller to protection buyer is significantly larger than the overall premium payable to the protection seller; or
• the payment of premium leads to an immediate incurred cost.

6.3

However, there comes a point at which the premium payable for protection can reduce significantly the economic risk that is transferred from the protection buyer to protection seller. A premium payable of 100% of the protection amount could leave the protection buyer in a position over the life of the transaction that was no better than if protection had not been purchased.

6.4

The PRA expects originators seeking to apply the securitisation risk weights to synthetic securitisations to take into account all relevant factors to assess the extent of risk transferred. As well as the size and timing of amounts payable to the protection seller, the circumstances in which those amounts are payable can undermine the effectiveness of risk transfer. The PRA expects firms seeking capital relief through synthetic securitisations to incorporate premiums in their assessment of SRT. In particular, the following transaction features may have a significant impact on the extent of risk transfer:

• premium which is guaranteed in all or almost all circumstances, eg premium which is payable upfront or deferred;
• those that could result in the amount of premium payable for protection being significantly greater than the spread income on the assets in the portfolio or similar to the size of the hedged position; and
• those under which the protection buyer retains the expected loss through higher transaction costs to the counterparty, in the form of premium or otherwise.

6.5

Originators should have regard to the statement on high cost credit protection issued by the Basel Committee on Banking Supervision (www.bis.org/publ/bcbs_nl16.htm).

6.6

The CRR requires maturity to be assessed in considering SRT. When assessing the effective maturity of synthetic securitisations, the PRA expects firms to consider whether the transaction contains an option to terminate the protection at the discretion of the protection buyer. The PRA will consider the following to be examples of features which generally indicate a positive incentive for the protection buyer to call a transaction, or at least to constitute grounds for discussion with the PRA prior to the conclusion of the transaction:

• the transaction contains terms, such as payments at maturity or payments upon early termination or significant premiums, which may reduce risk transfer;
• the transaction includes a requirement for the protection buyer to incur additional costs or obligations if they do not exercise their option to terminate the protection; and
• there are pre-agreed mechanisms, for example ‘at-market unwinds’, where the protection seller and protection buyer agree that the transaction can be terminated in the future at a ‘market’ value and specifies aspects of how the value is calculated.

(CRR Articles 243, 244 and 337)